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Big rescue money

October 25, 2008 2:52 pmOctober 25, 2008 2:52 pm

Via Yves Smith, an important article in FT Alphaville about the inadequacy of the bailout so far: despite
the big-sounding numbers, financial institutions are losing capital faster than governments are putting it in.

I’d add a couple more data points: Japan’s bank bailout in 1998 was more than $500 billion, in an economy whose dollar GDP was only about 1/4 that of the United States today. Do the math. And the just-announced
IMF loan to Iceland is $2.1 billion — that’s for a country with only 300,000 people. Both of these numbers seem to suggest that an eventual outlay of $2 trillion is in the realm of possibility.

The gist is they are using the federal money to buy each other out, not to lend.

But there is good news. According to Galbraith, because the U.S. had F.D.R., the mechanisms to handle this crisis are in place, though not yet used. Because other countries do not have the systems, all the liquidity
is lining up to buy U.S. debt. So we can borrow to dig our way out. We just have to get it right. And we should do it before other countries. Last Chance.

Japan and especially Iceland are very special cases (Icelandic banks owed $45.9bn to foreign lenders, with the largest lender Germany, $1.8 billion only British deposits, etc. So they were banking for the whole
world!) You know better, Paul. Probably a good chunk of the total net housing-bubble-loss and paper (shares, etc) loss would give a better estimate. Being a non-economist I can’t say what’s
the amount of these contained in a typical bank’s capital, but your data points look ridiculously shallow and irrelevant.

Prof. Krugman, In your discussion of what presidential candidates would do with regard to the economy with Charlie Rose, you discussed Obama, but did not discuss McCain. It is safe to say you disagree with McCain,
but what do you think he would do and why would it be inadequate?

I’ve been reading that banks such as J P Morgan Chase are hanging on to their bailout money to buy other failing banks rather than to loan it out as intended. Also, executive pay is still in the stratosphere.
Apparently, the bailout was little more than the Bush regime’s last ditch effort to raid the public treasury. Next time, maybe we’ll realize that it would be better just to let the system implode.
No matter what we do, Wall Street’s piggish greed that shocked, shocked Alan Greenspan will find a way to steal even more money.

The priority for rescue, common sense would suggest, ought to be Market mechanism and next home owners. The focus on institutions is probably misplaced and not contributing to financial productivity.

These failed institutions need to restructure and change their policy premises as only a competitive free market can enable.

Rescuing market mechanism implies need to find ways to reduce mortgage values commensurate with fall in home values. A direct subsidy to homeowners for the value gap and securitization of the subsidy may help. It
would also reduce the cash flow by spreading it over the years.

Ok this idea may not be also realisitic, but something tangible and sensible ought to emerge from somwhere.

I take this to mean that the potential aggregate losses to banks, including all mortgage foreclosures and credit card defaults, could be in excess of $2 trillion. I find it mindboggling that credit standards became
this lax. It’s also puzzling to me that this much value could simply evaporate over the course of a few months. One would think that if the residual value of all the houses, flat-screen TV’s, etc.,
that make up the bank losses were subtracted from the $2 trillion, the net loss would be much less. To put this in perspective, if existing houses cost $200,000 each, $2 trillion would buy 10 million houses!

The transition from metal to paper, via gold backing, lead to rampant ‘cheating’ and later that ‘cheating’ became the norm about money itself.

The transition to computerised money has led to plethora of new finanical instruments. These not only go past the innovations paper money brought about (cheques, Hundis, bonds, equities, interest bearing deposits
etc etc) but have opened up new vistas for greater opportunities and expansion.

The technology capabilites have not decreased, the commodity and mineral supplies have not reduced either. The demands have certainly not decreased. The opporunities for service sector economy remain highly elastic.
It is just the arrangements of exchange, which we call finance and economics which appear to need tinkering.

Instead of looking at Japan, Iceland to draw some lessons, it may be more useful to focus on matters like how these broken financial instruments can be fixed to circumvent the looming depression.

Give us some reaction to the Treasury’s latest injections of capital into regional banks. They do not appear to be separating good banks from bad banks, and instead are just throwing good money at banks that
have huge loan exposures on the books. First Horizon, according to Merrill Lynch, is exposed to Florida housing, home equity, construction and commercial real estate loans that will continue to degrade. Yet
the Treasury just have the more than $800 million. If FHN is considered a good bank, and is expected to use the money to make loans (right), or buy other banks, what does that say about the quality of the remaining
banks? The same question can be asked of injections to Sun Trust, Regions and Key–all of which are exposed to huge loan losses in areas that have not even begun to be hit yet. And it’s just unacceptable
that taxpayer money is being given to these weak banks who made bad loan, paid executives highly, and are still paying dividends to shareholders! This money would be better spent on helping stressed homeowners,
the unemployed, the poor and other taxpayers who are suffering.

Like some wise person once wrote, running a deficit is a secondary concern given the nature of the beast — right?

Just so long as that second trillion is a down payment on our future, a debt-relief super-stimulus to taxpayers to rescue individuals and families by improving personal balance sheets. That money will make its way
to banks, auto makers, all sorts of credit mongers, and will be a double-edged sword in that it may sharply decrease the demand for credit at the consumer level.

For that double-edged sword to be such a beast slayer, Congress must — must — follow with re-regulation of all things credit/banking/insurance/investment related.

Think of a country where credit scores all go to excellent in one fell swoop, where all the false wealth we were sold is placed in check.

Sure, consumption will still be curtailed, but this is a golden opportunity to sell responsibility, personal and corporate. We are sorely in need of a spanking and a timeout, and some tough love.

Give each taxpayer $10,000. Legislate that money be collected back by government at a rate of $500 per taxpayer over 20 years, with the stipulation that the revenue be used for infrastructure, energy, health and
education.

So bring on the $2 trillion, even three. Just get the citizens into the game. Level the playing field in one fell swoop, and reset the rules of the game at the same time and enforce them.

On one hand the banks are using the money to buy other banks, but on the other they can write off the losses of their acquisitions. In reality that is the government buying the troubled assets, and incurring an
even bigger loss for this mess.

Prof Krugman, I hope u can clarify the following issues. No details have been raised in the media about two things in all this bailing about:

1) If Investment-Bank ‘A’ made a side bet (the politically correct can call it an ‘investment’) with I-Bank ‘B’. Then, the bet matures, and there is one winner IB ‘B’,
say, and one loser IB ‘A’.

Now, if because of too much foolish overbetting in it’s portfolio, IB ‘A’ is UNABLE to pay the winner IB ‘B’, and IB ‘B’ has a hole in its ‘assets’
because of this bet; can BOTH BANKS (WHICH HAVE SINCE BEEN MERGED WITH DEPOSITORY INSTITUTIONS) apply to Paulson for money to make them whole? HOW DOES THIS ‘ECONOMICS’ WORK? Who will give us answers
as to not bailing out futile bets of no economic value?

Meanwhile, the taxpayers get a hole in their pockets!

and, 2) why is all this NOT inflationary? Krishna Guha suggests in his FT column (10/22/08) that it COULD be inflationary. The FED COULD overshoot?

The answer ironically is to make banks less regulated. The job that regulation would do has already been done by the market…just look at the mess we’re in!

Again, if ENOUGH banks fail, others should eventually pop up to lend to the people they choose. If it doesn’t happen, then I don’t see why the government trying to orhcestrate it is good for the world.

From how I see it. It seems that the money is still caught up because of the uncertainty involved in the Housing Crisis as well as the Credit Crisis. Many people unable to borrow from home equity or having equity
tapped out as well as unable to procure personal loans, resort to using credit cards to support their living. As unemployment increases, the liklihood is that housing will again be unaffordable or the people
who have bought on the dips in housing who also happen to lose their jobs will be unable to afford the houses once again. Besides the drop in home defaults and foreclosures in California has only been delayed
due to new regulations. Instad of being able to evict and forclose, The Banks have to try to work a deal out with the defaulting homeowner for at least 30 days before they can foreclose:

“The big drop came in September, when a new state law took effect that blocks lenders from initiating foreclosure proceedings until 30 days after contacting the borrower or making “due diligence”
efforts to do so.” – excerpt from

The situation is worse then it reveals. When the unemployment statistics comes out on Thursday Morning the numbers will also be significant, although it still does not reflect true unemployment (includes those who
have exhausted their unemployment benefits and are no longer considered unemployed.)

Another indicator that is indicative to Consumer spending are the malls and stores. If you have some time. Go on a Sat or Sun to a mall. You can see how many people are in the stores and how many less are at the
registers and perhaps perspective can be gained.

In essence, rate cuts and bailouts will not make a significant impact on the overall economy. Our economy has shifted from Factories to Services due to overseas export of factory jobs and shifting of jobs to the
services sector. Many services jobs will be eliminated due to 10-25% job cuts. I suspect that even communications may take a hit in the near future as spending decreases. Companies like Verizon and Sprint Communications
will take a hit and will perhaps have layoffs in the next few weeks to accommodate the decrease in expenditure and even perhaps cancellation of some unnecesary phone services.

The solution to the problem is perhaps job creation. If the private sector jobs are unavailable, public works project should be instituted to create the jobs such that the housing bubble does not deteriorate further
since people will have stable income to pay for their houses. Once housing stabilizes, the rest of the economy can also gain a footing and as a result. The private sector can then have confidence that spending
can be supported by consumers who have stable jobs.

Job Creation ==> Income ==> Housing (can be supported)

In Chinese Philosophy Earth generate metal. In his case Housing = Earth, from which metal = wealth can spring forth. Without a stable earth, wealth cannot be generated. That is my observation of the matter.

United Steelworkers President Leo Gerard has raised serious concerns about the Treasury bailout of nine financial firms, saying the cost was double what it should be and the investment helped the companies’
stockholders, rather than the taxpayers.

In a letter sent to Treasury Secretary Henry Paulson, Gerard questioned the wisdom of Treasury investing $125 billion of taxpayers’ money into nine financial institutions, including the firm which Paulson
recently headed, Goldman Sachs.

An analysis, prepared by the USW, uses traditional Wall Street valuation techniques to demonstrate that the Treasury’s investment in Goldman and the other firms was worth approximately half of the price paid
and that the other half was a gift to the firms’ shareholders. The analysis was done by comparing Treasury’s investment to one made just 20 days earlier by billionaire investor Warren Buffett.

In the letter, Gerard says:

This behavior is simply outrageous. Half the money is invested and the other half of the public’s money is gifted to institutions after they paid out hundreds of billions in undeserved bonuses and shareholder
dividends and engaged in reckless speculation.

Gerard likened the bailout to someone who overpays for a car.

This is no different than if you paid me $10,000 for a car for which no one else would pay more than $5,000. You bought it for $5,000 and gifted me the other $5,000. In my world such gifts are rarely offered to
working people.